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Speculative Trading In Oil Market Is Driving Prices Higher, Not Demand

by Michael Rogan

Special to Tropical Breeze

Anyone who has attended one of our workshops or heard our radio program has probably heard me say the often quoted — “It’s not what people don’t know that hurts them, it’s what they do know that just ain’t so.” Consequently, one of the most time consuming parts of my job is to research, in detail, the facts surrounding whatever new fear is being broadcast by the single-minded media, so that I can help lend perspective to our clients.

With this in mind, I am going out on a limb in this column to tell you the facts surrounding today’s sky high oil prices, and why I am certain oil prices will be much, much lower within a few years. First, you need to have some background on the prices of oil. In the early 1970s, the first oil embargo of that decade pushed the price of a barrel of oil above $10 for the first time ever. By 1979, the second oil embargo pushed prices up to nearly $40 a barrel. Given that oil is a cyclical commodity, it should have surprised few people that by 1986, only seven years later, the price of a barrel of oil had fallen back to around $10. Not long after, in 1990, Saddam Hussein invaded Kuwait and even lit oil fields on fire, with the ensuing panic driving prices back up to over $40 per barrel. What no one seems to remember, however, is that eight years later in 1998, prices of this cyclical commodity again dropped back to just over $10 a barrel. Do you remember that only eight years ago, a gallon of gas cost less than one dollar?

Now I understand that the media groupthink has reported consistently the story that global demand for oil has risen dramatically lately, led by fast growing countries like China, thereby permanently changing the equation of supply and demand for oil. It has been widely reported that high prices are here to stay. I had a hard time believing that, so I decided to research the facts.

If oil prices had justifiably increased seven-fold in eight years, I would have expected to see an enormous increase in global demand to explain the price. In fact, the world’s demand for oil has risen less than 20% — total — over the past eight years. And China, which is growing quickly, has accounted for a smaller increase in demand in each of the past two years. In 2005, China’s demand increased by 400,000 barrels a day, which sounds like a lot until you compare it to the 2005 global demand of over 83 million barrels a day. And the supply of oil already drilled and on hand today is at levels not seen since 1998. The US Strategic Oil Reserve became completely filled this year for the first time in its history.

So if supply and demand are not the cause of the huge price increase, it must be those greedy oil companies, with their outlandish profits, right? Well, if you were an oil executive over the past 20 or 30 years, your job would have been to create a business infrastructure that could operate profitably at around $20 a barrel for oil, since that has been the long term average price over the period. So if prices spiked suddenly to $70 a barrel, you could not avoid making large profits. But that doesn’t mean you would have any ability to cause that to happen, any more than you could have prevented prices from dropping down to $10 a barrel twice in the past 20 years. So what’s the cause?

Certainly the synchronized global expansion of the past few years is partly responsible for all commodities becoming more expensive as global demand increased. However, with regards to oil, it has been estimated recently that the amount of speculative money trading in the oil market today is perhaps 1500% greater than just four years ago. As frenzied speculators moved away from global stock markets and began searching for new gambles, apparently many decided to bet on oil, gold, and other commodities. But it is exactly the presence of their “hot” money that leads to my prediction of much lower prices relatively soon. Once these gamblers decide the game is over, they will leave in a hurry. I’m predicting $40 a barrel this decade.

But here’s the point — if I am wrong or right, it won’t matter to my clients. As I have stated before, all of us should only make investment decisions pursuant to achieving our long term financial goals as spelled out by a comprehensive financial plan. The high price of oil and gasoline may cause you to change some of your spending habits (though I doubt it), but it should absolutely not cause you to change your investments or your long term financial plan. Making bets with your investments based on short term trends is gambling, and only the financially immature gamble with their financial future.

So I hope the facts have helped change your perspective. But don’t worry, there will soon be another media “disaster” I will be able to debunk. Stay tuned.